What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Overseas Commerce (TLV:OVRS) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Overseas Commerce, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.088 = ₪44m ÷ (₪629m - ₪129m) (Based on the trailing twelve months to September 2020).
Thus, Overseas Commerce has an ROCE of 8.8%. In absolute terms, that's a low return, but it's much better than the Infrastructure industry average of 4.7%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Overseas Commerce has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Overseas Commerce, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 8.8%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.On a side note, Overseas Commerce has done well to pay down its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Overseas Commerce's ROCE
Bringing it all together, while we're somewhat encouraged by Overseas Commerce's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 22% in the last three years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
One final note, you should learn about the 5 warning signs we've spotted with Overseas Commerce (including 2 which are significant) .
While Overseas Commerce isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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